Tuesday, May 26, 2009

Switching Horses on Oil Strategy

Thunder Horse turns 10 next month. BP's billion-barrel oil field, discovered in 1999 in the Gulf of Mexico, is a source of pride. It also is a reminder of what ails the oil majors.

Thunder Horse, which started up in 2008, will provide 42% of BP's incremental upstream production over the next three years, according to analysts at J.P. Morgan Chase. Unfortunately, it is also one of BP's few discoveries of such scale in recent memory. Neil McMahon of Sanford C. Bernstein calculates that less than half of BP's additions to reserves over the past five years have come through its exploration efforts.

BP has done better recently, especially in terms of reserves replacement. At its latest strategy presentation, the company promised production growth out to 2020.

But that target is open to question. BP must contend with declining production at existing, mature fields and has cut its capital-expenditure budget. Meanwhile, it also has committed to maintaining its dividend.

Trying to be all things to demanding investors isn't a dilemma peculiar to BP or even just the oil industry. But the majors, given their size and exposure to volatile energy prices and geopolitics, feel the pressure more than most.

This decade, many of them have chased scale and touted synergies from mergers. Investors have been unimpressed. BP, for example, invested $211 billion in capital expenditures and acquisitions between 1998 and 2008, according to Mr. McMahon. Its stock was one of the worst-performing across that period.

Shares of ConocoPhillips, another big acquirer, have performed better. However, its stock crashed hardest over the past year as falling energy prices exposed flaws in its acquisition strategy.

Absent high energy prices, the majors' investment appeal is under scrutiny. Is it about share-price growth, high payouts, or both? To a large degree, they have ceded exploration and technology leadership to smaller competitors and the oil-services sector.

Of the majors, Exxon Mobil has achieved the best balancing act, reflected in its high valuation multiples. And with ample net cash, it can continue doing so. The clock is ticking on several others.

Barring Exxon, all of the majors outspent their operating cash flow on capex and dividends in the first quarter, according to IHS Herold. Leverage for most is low, but straining for growth while dishing out lots of money to investors without the underlying cash flow to match isn't sustainable.

Another round of megamergers, even if allowed, wouldn't likely cut it with investors. Acquisitions of some smaller competitors to pick up choice assets and underpin stable production are fine at the right price. But this also requires financial flexibility and can only be an adjunct to organic reserve replacement over the long term.

Above all, the majors need to reassure investors that the regular distributions of cash are sustainable. That means, when it comes to replacing barrels, proving they can go out and find, not buy, more Thunder Horses.

if you're implying that it's plagiarism, the blogger has clearly stated "from the wall street journal" at the top of his post. seems to me most blogs do this, doesn't seem scandalous to me. it would be more dishonest to edit it heavily, then state that it's from the WSJ, wouldn't it?

Not large chunks. The entire post. That's why it's indented - to show it's a direct quote.

WSJ makes their articles free for a short time, then puts them behind a paywall. Every once in awhile I "liberate" one that I find particularly interesting, before it disappears. I am not trying to claim credit for writing it, and always include a link to the original source.

I think her point is to make these articles more well known to people. I was in her blog post on the Oil Drum about bartering back in February. As one of the interviews from USA today I actually was flattered to see my best barter show up on other sites on the web. Keep it up. We need every resource to survive and take our economy back!!